Hovnanian Enterprises, Inc. — Q2 FY2020 10-Q
Reporting period: Three and six months ended April 30, 2020. The filing was signed June 5, 2020. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Business context and results
Hovnanian builds and sells homes across six U.S. regions and provides mortgage and title services to homebuyers. The quarter overlapped with the early COVID-19 disruption. Management reported slower traffic and sales pace and increased cancellations in March and early April, while construction and home sales remained permitted in its markets.
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Total revenue | $538.4 | $440.7 | $1,032.4 | $821.3 |
| Net income (loss) | $4.1 | $(15.3) | $(5.1) | $(32.7) |
| Basic EPS | $0.63 | $(2.56) | $(0.82) | $(5.49) |
| Homebuilding gross margin | 14.5% | 13.3% | 13.7% | 14.0% |
| Cash from operating activities | Not separately presented for quarter | $79.7 | $(198.9) |
Financial position and liquidity
- Home sales revenue rose 22.4% in Q2 and 27.0% in the first half, mainly as deliveries increased 22.1% and 24.8%, respectively. Average selling prices increased modestly.
- Q2 homebuilding gross margin improved year over year; first-half margin declined slightly, reflecting higher cost-of-sales interest, incentives on first-quarter spec homes and delivery mix. Q2 diluted EPS was $0.60.
- At April 30, cash and cash equivalents were $232.8 million, restricted cash was $16.1 million, and total assets were $1.906 billion. Equity deficit was $495.1 million.
- Management reported total liquidity of $247.1 million, including the full $125 million draw on its secured revolving credit facility. It said available sources were expected to fund working capital through fiscal 2020; this is not a longer-term assurance.
- Operating cash flow was $79.7 million for the first half, compared with cash use of $198.9 million a year earlier. Investing used $21.3 million and financing provided $42.7 million. Cash-flow comparisons reflect, among other factors, inventory movements and mortgage-loan activity.
- Senior notes and credit facilities, net of discounts, premiums and issuance costs, totaled $1.584 billion; nonrecourse mortgages were $211.8 million. Debt increased from $1.480 billion at October 31, 2019. The company reported compliance with debt covenants but is restricted from paying preferred dividends and expects that restriction to continue.
Material changes and operating indicators
- Q2 net contracts were down 3.8% year over year, while first-half net contracts rose 13.3%. Q2 cancellation rate increased to 23% from 19% a year earlier.
- Backlog at April 30 was 2,383 homes valued at $958.1 million, versus 2,254 homes and $949.9 million a year earlier. Active selling communities fell to 132 from 147 year over year.
- Homebuilding pretax income was $27.6 million in Q2 and $39.9 million for the first half. The West segment’s pretax income declined materially year over year; Midwest and Southeast reported first-half pretax losses.
- First-half debt exchanges generated a net gain on extinguishment of debt of $9.3 million. The exchanges reduced or restructured certain outstanding debt but included new secured obligations, including 10.0% notes due 2025 and 10.0% secured term loans due 2028.
- First-half land and land-development spending was $232.3 million. The company contributed eight communities, including four active communities, to a new unconsolidated joint venture.
Outlook, risks and unusual items
- Management said COVID-19 effects could materially reduce contracts, deliveries, revenue, cash flow and profitability in future periods; the duration and severity were uncertain. It noted sales pace had improved after quarter-end but remained below pre-pandemic levels.
- To preserve liquidity, the company emphasized closing backlog homes, limiting spending, reducing or delaying land purchases and development, and drawing the full revolving facility. These measures may slow growth and reduce community count and deliveries.
- May 2020 restructuring actions included consolidating operating groups and divisions, phasing out the Chicago market as existing communities sell through, and workforce cost reductions. Management expected about $20 million of annualized overhead savings beginning in FY2021 and approximately $3 million of severance and related charges in Q3 FY2020.
- No specific full-year revenue or earnings guidance is provided in the supplied filing text. Management warned of possible future inventory impairments and restructuring charges, which could be material.
- Contingencies include a New Jersey construction-defect case with approximately $119.5 million in asserted remaining damages, potentially subject to treble damages; the company intends to defend the claims. In an EPA cleanup matter, the agency demanded $2.7 million, negotiations were ongoing, and the company said it had adequate reserves, while noting the ultimate obligation was uncertain.
- Other risks include high leverage and restrictive debt covenants, refinancing and liquidity access, housing-market and mortgage-financing conditions, construction costs and labor availability, regulatory and environmental requirements, and warranty/construction-defect claims.
Important facts for investors to verify
- Post-quarter trends in net contracts, cancellations, backlog, deliveries and community count as COVID-19 effects evolve.
- Cash availability and covenant headroom, including the use of the fully drawn $125 million revolver and upcoming debt maturities.
- Whether planned spending reductions and operational changes preserve liquidity without materially weakening future sales capacity.
- Regional margin performance, particularly the West, Midwest and Southeast, and the effects of delivery mix, incentives and interest expense.
- Developments in the Great Notch litigation and EPA cleanup negotiations, plus any changes to warranty reserves or inventory impairment assumptions.
- Whether the anticipated FY2021 overhead savings and estimated Q3 restructuring charge are realized as described.